Five myths about the ‘fiscal cliff’

By Maya MacGuineas,

Maya MacGuineas is the president of the Committee for a Responsible Federal Budget.

by Maya MacGuineas
At the end of the year, the country faces an abrupt series of broad tax increases and blunt cuts to most federal programs unless Congress and the White House act. Most policies that have set up the “fiscal cliff,” a term coined by Federal Reserve Chairman Ben Bernanke, were never really intended to take effect. Many were designed to try to nudge lawmakers to find longer-term solutions to reduce the nation’s unsustainable deficits. Let’s set the record straight about what the fiscal cliff is — and how we can avoid it.

1. The fiscal cliff is mainly about defense cuts and the expiration of the Bush tax cuts.

A good amount of the attention that the fiscal cliff receives in the news media and on Capitol Hill focuses on defense spending cuts or the expiration of the George W. Bush-era tax cuts (which President Obama renewed in 2010). These do make up a large portion of the fiscal cliff: more than $500 billion in defense cuts and more than $2.7 trillion in tax increases over the next 10 years. But they’re just the beginning of the cuts that would affect the economy.

For example, if lawmakers do not patch the alternative minimum tax, that tax threshold, which applies to 4 million people today, could ensnare nearly 30 million people, raising their tax bills by an average of $2,700. Additionally, non-defense discretionary cuts would hit programs for low-income people such as housing and energy assistance. And more than 2 million Americans would lose their federal unemployment benefits.

Some have called on lawmakers to postpone parts of the fiscal cliff by waiving the budget sequester or extending the tax cuts without offsetting the costs. As the end of the year inches closer, such calls are likely to increase.

But making either of these moves without putting in place the beginnings of a deficit-reduction plan would send a dangerous signal to global markets, businesses and the American public that Washington is not serious about fiscal responsibility and, frankly, can’t govern.

In recent months, Moody’s Investors Service, Standard & Poor’s, and Fitch Ratings have said that the United States could lose its AAA credit rating — or face further downgrades in the case of S&P — if steps are not taken to reduce the national debt. Such a downgrade could harm economic confidence and growth down the road.

Furthermore, the threat of the fiscal cliff is the only thing propelling policymakers to work out a larger deal; without it, the prospects of fixing this problem dim significantly.

Some experts have argued that going over the cliff wouldn’t cause much immediate economic harm and that any damage could quickly be reversed by retroactively waiving the tax increases and spending cuts. That’s like saying: “Don’t worry about being run over — the car will be off you shortly.” In most cases, the damage is already done.

There is no way to know how the economy and the markets would react to our going over the fiscal cliff, but we should not be willing to find out. As Alan Kreuger, chairman of the White House Council of Economic Advisers, said Friday, there would be a serious psychological effect as well, leading people to think “that government is not capable of solving problems that it’s there to solve.”

Thus far, the markets still believe that policymakers would not be so foolish as to willingly cliff-dive — but the moment they are proved wrong, the markets could go into an expensive tailspin. Like a good reputation, market confidence is hard to get back once you ruin it.

The Congressional Budget Office — not prone to scaremongering — projects that the fiscal cliff would cause the economy to shrink by nearly 4 percent in the first quarter of 2013, enough to cause a double-dip recession. Why risk that?

4. Going over the fiscal cliff will make it easier to get a “grand bargain” on debt reduction.

Some political strategists argue that going over the cliff could turn up the pressure on deficit reduction and make it easier to reach a consensus. This logic goes: Once the tax cuts have expired, Congress can start from a different budget baseline, so that what would have been a tax increase on Dec. 31 will be a tax cut as of Jan. 1. I tried this logic on my 8-year-old son, who said: “Seriously, Mom? That is the dumbest thing I have heard,” reaffirming my sense that this kind of reasoning doesn’t carry water.

We are going to have to make some hard choices to fix not just the cliff but our broader budget problems. For Republicans, that means reforming the tax code in a way that would raise more revenue. And for Democrats, it means embracing structural entitlement reform, with strong protections for the most vulnerable. Waiting for a new baseline doesn’t make this easier, but it does put the country at tremendous risk.

And the idea that it would be easier to get a bipartisan compromise after going over the fiscal cliff completely misjudges how bad the blame game would be at that point. Politicians might think they would work it out quickly, but that’s a dangerous gamble.

5. Going over the fiscal cliff would be the worst possible outcome.

All the attention the fiscal cliff gets from lawmakers, businesses, experts and journalists can crowd out the key message. The looming cliff is an opportunity to make real progress on addressing the central, long-term fiscal challenge facing the United States: debt as a ballooning share of the economy.

There’s no doubt that going over the cliff would impose serious economic costs. But even worse would be blundering along on our current path without change. Our national debt threatens much larger economic consequences than those posed by the fiscal cliff. Down the road, rising debt could substantially hold back economic growth and send the country into a fiscal crisis that would be far worse than even a double-dip recession.

Among all the myths about the fiscal cliff, there is a certain truth. We will have to make changes to our fiscal course — either on our own terms or when the markets force us to. We should choose the first path.